Investing in Rental Houses
(An excerpt from 69
Ways To Make Money In Real Estate)
By Steve Gillman - 2006
If they have positive cash flow, rental homes are a great
long-term way to make money in real estate. It is an inflation
adjusted retirement plan, since rent - and so your income - goes
up with inflation. The downside? Landlording really isn't much
fun, and you typically wait a long time for the big pay-off.
Many investors confuse making money from rental homes with
making money speculating on price appreciation. You can certainly
get do both with rental homes. However, this desire to gamble
on rising prices leads many to buy rental homes that have more
money going out than coming in.
It's difficult to argue that you shouldn't do this if you
just sold a home for $120,000 that you bought for $90,000 two
years ago - even if you had negative cash flow of $3,000 per
year. This is risky, however. You could quickly find yourself
in trouble if you own several such investments and they don't
go up in value.
Another important point is that there is a limit to how many
negative-cash-flow homes you can own. At a loss of $3,000 per
year, how many can YOU afford? On the other hand, if your rental
homes are paying for themselves and even throwing off some real
cash flow, you can own any number of them, right. The more the
Obviously, then, my number one recommendation is to buy rental
homes that will have positive cash flow from the first month
you own them. Think about this for a moment. If you bought a
home for $90,000 and thirty years later it DROPS in value to
$60,000, but meanwhile you paid off the loan and had cash flow
the whole time, you're doing great. You have $60,000 cash whenever
you want to sell, and better cash flow now that the loan payments
are done. That is much more secure than gambling on appreciation
while losing money - but you still get any appreciation gains
Rental Houses - Avoid These Mistakes
Being a landlord and making money with rental homes is a big
job. There are many great books that can help you avoid the hardest
kind of learning - learning from your own mistakes. I recommend
getting educated. In the meantime, here are some common mistakes
that investors make with rental homes. Watch out for these.
Mistake : Not accounting for all expenses.
You hear something like this all the time: "The mortgage
is $800, and the rent is $900, so my cash flow is $100 per month."
You even see real estate books and course that fall prey to this
kind of fast and sloppy accounting. Cash flow is what you have
(or hope to have) after all your regular expenses, which include
taxes, insurance, maintenance, repairs, water bills, utility
bills between tenants, garbage collection, advertising costs,
and anything else that it costs to have that home.
Mistake : Assuming too much income.
If the rent is $1,000 per month, the rental income for the
year will be $12,000, right? Only if you are very lucky! You
have to plan on some vacancies. If tenants in the area stay around
for a year on average, and it takes a month to clean and re-rent
a home, plan on $1,000 less, or $11,000 annual income.
Mistake : Saving money by not repairing things or making necessary
This short term way to increase cash flow is often referred
to as slumlording. Long term, it means not just lower rental
income for you, but more problem tenants. Consider the math and
you'll see the logic of having a nice place. New carpet and repairing
a dangerous porch might cost $3,000, but if you roll it into
a refinancing (let's say a 7% 30-year loan) it adds just $20
per month to your expenses. Even on a credit card it might cost
you only $60 per month. You might be able to get that much more
in rent for a nicer place, and you'll have fewer problems.
Mistake : Not doing a background check on prospective tenants.
I once rented to a woman who admitted to doing jail time for
driving without insurance. She seemed very honest and up front
about it, so I didn't investigate further. I later discovered
that she actually had been arrested for writing bad checks -
a lot more relevant information for a landlord. She ended up
in jail again, and was of course unable to pay rent. I could
have gotten a simple criminal background check and avoided the
problem. Check out those tenants.
Mistake : Trying to do too much by yourself.
If you want to have just a few rentals and you enjoy fixing
toilets and arguing with late-paying renters, you can do everything
yourself. However, if you want to be a real estate investor and
really make some money, your time is better spent finding and
buying new properties than repairing broken windows. How many
properties could you handle if you did everything yourself? Hire
help when you need it.
Probably the biggest problem with buying single-family homes
is that it can be tough to get positive cash flow. This has become
a bigger problem recently, because for years now the prices of
homes have been rising faster than rents. What can you do about
Avoid the common practice of buying properties that lose money
every month on the assumption that you can make your profit when
you sell them in a couple years. This strategy is about to get
a lot of investors in trouble soon, because home prices in many
areas have stopped rising or even started falling (I'm writing
this in December of 2006).
Also, how many negative income streams can your regular paycheck
support? This is always a problem with investing in properties
with negative cash flow. With positive cash flow, you can own
as many as you want.
One way to get that positive cash flow is to invest in mobile
homes on land. These often rent for close to what small homes
get, but cost less than half as much. Other ways to get positive
cash flow involve either finding ways to reduce expenses or increase
income, or both. Here are some ways to do that:
1. Lower payments.
If you can't get a lower interest rate from the bank, see
if you can get seller financing. Also, amortize the loan over
30 years, not 15.
2. Lower operating costs.
Look for any unnecessary expenses that the property has,but
which can be cut. These might include getting a cheaper management
company, finding cheaper insurance, and getting the property
taxes lowered if the property is over-assessed.
3. Raise rent.
Check area rents to see if an increase is feasible. Make improvements
that will enable you to raise the rent more than enough to cover
the cost of financing those improvements.
4. Lease it with an option.
You can often collect higher-than-market rent when you lease
a home and give the renters an option to buy it.
Buying rental houses is one of the easier ways to get started
in real estate investing. If you do it only when and where you
can get positive cash flow, it is also a very safe way to invest.
Another big advantage it has, is that you have two markets for
your properties when you are ready to sell them - both investors
and regular home buyers.